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Home Market News

Emerging Markets See Risks With Maturing USD-Denominated Debt, But Fed’s Changing Interest Rate Views Could Provide Some Slight Relief

by admin
January 13, 2019
in Market News
0
Emerging Markets See Risk With Maturing USD Denominated Debt But Feds Shifting Interest Rate Policy May Provide Slight Relief Market News

Emerging Markets See Risk With Maturing USD Denominated Debt But Feds Shifting Interest Rate Policy May Provide Slight Relief Market News

Emerging Markets will experience problems with maturing debt. The U.S. dollar is the most important factor for Emerging Markets. With a stronger dollar, these economies will become weaker. As the U.S. Federal Reserve continues to be in a rising rate environment, the U.S. dollar strengthens, which makes repayment of USD-based debt to be more expensive for emerging economies. However, despite several rate hikes in 2018, the Federal Reserve appears be to temporarily backing off its hawkish stance after a severe market sell-off in late 2018 was blamed in part due to Fed’s role in increasing interest rates.

“Won’t a strong dollar help emerging economies by making their exports cheaper?”

Well, yes and no. A stronger dollar makes foreign currencies cheaper, increasing their exports. However, the current problem is that these markets are over run with massive amounts of dollar-denominated debts. Weaker currencies make it tougher to repay those debts. That’s important to be aware of as trillions of dollar-denominated bonds mature over the next few years.

Source: Investopedia
Source: Investopedia

Let’s dig a little deeper. . .

Since 2009 – Emerging Market governments and corporations have enjoyed cheap dollar debt.

The Federal Reserve started lowering interest rates to historic lows also known as, Quantitative easing to save the financial system during 2008. This caused two important by-products.

First – U.S. investors were desperate for yield. They couldn’t make sufficient interest from government bonds. Therefore, they lent money to foreign countries at higher interest rates, which also came with higher risk.

While these borrowers like Turkey and Greece didn’t deserve favorable rates, lenders obliged by giving them these rates.

And Second – Emerging Market governments and businesses seized this opportunity to get cheaper dollar financing. They were able to obtain dollar loans at lower rates than what was available in their local markets.

For example, cash-rich foreign companies would borrow debt denominated in dollars so that they could get the lower U.S. interest rates. They would convert it into their domestic currency. Then, they’d lend it at higher local rates via money market accounts or other loans.

Everything seemed fine as lenders and borrowers fed off each other. Yield deprived investors got that extra 1-2 two percentage points of fixed income with enthusiastic foreign debtors able to binge on cheaper debt.

How could this go wrong?

The Fed started tightening the economy by raising interest rates in December 2015. This was a historic event as this was the first interest rate increase in seven years. The first few hikes were relatively small at only 25 bps (.25%) each. This didn’t motivate investors to dump high interest, riskier foreign investments. At the start of 2018, the Fed’s overnight rate hit 2% (now at 2.5%). That’s a whole new story.

Source: Investopedia
Source: Investopedia

Now U.S. investors can get higher yielding fixed income in the country that is generally “risk-free”. When these investors sold out of Emerging market investments, things spiraled downward.

Despite this, the real problem that nobody is talking about is that these emerging market governments and corporations have massive amounts of dollar-denominated debts maturing over the next three years – nearly $3.25 trillion (90% being corporate bonds).

More than half of that debt comes from China

To put things in perspective, the Chinese government and business owe approximately $1.75 trillion – nearly 55% of the total – of bonds maturing through 2020.

They won’t be able to refinance to cheap terms as worldwide rates increase. When these bonds mature, debtors take on new debt to cover the maturing ones. Since Emerging Markets don’t have wealthy investors with reserves on hand, they need to float, or short maturity funding, dollar-denominated debts.

Source: Palisade Research
Source: Palisade Research

Unfortunately, recent rate hikes by the Fed have skyrocketed the cost of short-term dollar funding. These levels haven’t been seen since 2008. The dollar continues to climb, which means it will take more local currency to repay the same dollar debts. Therefore, the era of risky, poor credit economies getting cheap dollar financing is over.

These over-indebted emerging markets will have to amass large dollar reserves over the next few years. With interest rates increasing and a stronger dollar, the cost to roll this debt poses a risk for emerging markets, especially those with poor credit ratings.

Article By: Donald Brewster

Tags: borrowingChileChinacommoditiescommon stockDow Jones Industrial Averageeconomicsemerging growthemerging marketsFederal Reserveforeign investmentglobal stock marketIndiaIndonesiainterest ratesinvestinginvestmentmarket newsMexicoNASDAQnewspublic companyrate hikeS&P 500salesservicessmall cap companiessmall cap stockssmall capsSouth AfricaSpotlight GrowthSpotlight Growth Stocksstock marketstockstradingturkeyus dollarUSDUSD debt
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